Closed-End Funds: What They Are and How They Work

Key takeaways
* Closed-end funds (CEFs) issue a fixed number of shares in a one-time public offering and then trade on a stock exchange like stocks.
* Market price can differ from net asset value (NAV), creating premiums or discounts that present opportunities and risks.
* CEFs often use leverage to amplify returns, which increases both potential gains and losses.
* They tend to offer higher yields but are less liquid and usually accessible only through a brokerage.

What is a closed-end fund?

A closed-end fund raises capital by selling a set number of shares in an initial public offering. After the IPO the fund stops issuing new shares; its existing shares trade on an exchange among investors. This contrasts with open-end mutual funds and many ETFs, which continuously issue and redeem shares as investors buy and sell.

How closed-end funds operate

• Professional management: A portfolio manager actively buys, sells, and holds assets on behalf of shareholders.
• Secondary-market trading: Shares trade intraday on an exchange and are bought and sold between investors through a brokerage.
• Limited share supply: Because the fund does not continually issue or redeem shares, supply is fixed (except for certain interval funds that periodically repurchase shares).
• Distributions and fees: Like other pooled vehicles, CEFs distribute income and capital gains and charge an annual expense ratio.

Net asset value (NAV) vs. market price

• NAV is the per-share value of the fund’s underlying holdings, calculated regularly.
• Market price is set by supply and demand on the exchange and can deviate from NAV:
• Premium — market price above NAV.
• Discount — market price below NAV.
• Causes of deviation include investor sentiment about the sector, manager reputation, performance history, and market liquidity.

Leverage and performance considerations

• Many CEFs use leverage (borrowed money) to try to boost returns. Leverage can increase yield in favorable markets but magnifies losses in downturns.
• Because CEFs don’t need to keep large cash reserves to meet redemptions, they can deploy more assets and use leverage more freely than open-end funds.
• Evaluate CEFs by looking at NAV performance, market-price performance, discount/premium trends, distribution sustainability, leverage levels, and expense ratios.

Types of closed-end funds

CEFs cover a broad range of strategies, including:
* Municipal bond funds (largest by assets under management)
* Corporate and government bond funds
* Equity funds (domestic, global, international, emerging markets)
* Real estate and commodity funds
* Business development companies (BDCs)

Fast fact: Global funds may combine U.S. and non-U.S. securities; international funds hold only non-U.S. securities; emerging markets funds focus on higher-growth, higher-volatility regions.

Example

One well-known CEF is the Eaton Vance Tax-Managed Global Diversified Equity Income Fund (EXG), an income-focused fund that illustrates how CEFs blend income generation and capital appreciation objectives.

Advantages and disadvantages

Advantages
* Potential for higher yields, particularly when leverage is used effectively
* Opportunity to buy shares at a discount to NAV
* Intraday trading flexibility like stocks

Disadvantages
* Market price can diverge from NAV, adding valuation risk
* Use of leverage increases volatility and downside risk
* Generally less liquid than open-end funds and typically available only via brokerage accounts
* Discounts can persist, and shares may be hard to acquire except from other investors

Closed-end vs. open-end funds — summary

• Issuance: CEFs issue a fixed number of shares in an IPO; open-end funds continuously issue and redeem shares.
• Trading: CEFs trade on exchanges at market prices intraday; open-end funds are priced once daily at NAV.
• Liquidity management: Open-end funds must hold liquidity for redemptions; CEFs do not, allowing greater use of leverage and full investment of assets.

How to evaluate a closed-end fund

Consider these factors when researching CEFs:
* Discount/premium history and current level
* NAV and market-price total returns over multiple timeframes
* Distribution sources and sustainability (income vs. return of capital)
* Leverage ratio and interest costs
* Expense ratio and manager track record
* Portfolio composition and credit quality (for bond funds)

Bottom line

Closed-end funds are pooled investment vehicles with a fixed number of shares that trade on exchanges. Their market-driven pricing, potential use of leverage, and fixed share supply create distinct opportunities and risks compared with open-end funds. Investors should assess discounts/premiums, leverage, distribution policies, and manager performance before investing.